With yield farming, earned rewards are rarely straightforward. In order to earn more rewards, yield farming requires holders to pledge large amounts of capital. Therefore, not all crypto holders will find benefit in yield farming. In addition, DeFi is still embryonic and may have additional inherent hidden risks.
Due to application of smart contracts, popular DeFi protocols are usually developed by small teams with limited resources. This lack of resources may be a serious problem, causing them to bootstrap code and increase the risk of software vulnerabilities or smart contract bugs. Hacking is also a serious risk with successful hacks of even well-known audited protocols.
Whale Movements and FUD
The risk is not limited to the technical layer, however. Ample warnings of this can be found in the recent example of SushiSwap. This DeFi protocol was created by an anonymous developer known by the pseudonym Chef Nomi. Instead of working with an order book exchange, SushiSwap utilizes an AMM model (automated market-making). With this model, liquidity providers add funds to liquidity pools. The SUSHI token entitles holders to the project's governance and rewards them with a portion of the fees traders pay.
Just over a week after going live, users had already locked over $1.27 billion worth of crypto assets in Sushi contracts. However, Chef Nomi then obtained over 38,000 Ether (ETH) in cashing out a stake of SUSHI tokens. SUSHI fell from over $5.3 to $2.3 in less than a day, a price drop of over 70%. The actions by its creator led to subsequent accusations of him running an exit scam.
In response, Chef Nomi gave his admin keys to Sushi investor and FTX CEO Sam Bankman-Fried, who thereafter announced his decision that no single entity should be allowed control the platform. The SUSHI protocol subsequently switched to a multi-signature format.
Smart Contract Bugs
Another notable case highlighting the risks associated with smart contracts is that of Yam Finance (YAM). YAM is a DeFi project that discovered a bug in its smart contract that made it impossible for the community to reach a quorum.
Yam Finance had a smart contract that was unaudited, a fact its creators made clear. However, by the time the bug was discovered, unaware investors in pursuit of short-term gains had locked in over $500 million worth of crypto assets on it. YAM crashed from around $100 to $1 in a single day, with prices trending at around $0.02. This happened all before YAM was listed on top exchanges.
Wrapping It Up
While there are many opportunities for gains in the DeFi space, there also are many risks that must be considered. Risks related to the inherent volatility of cryptocurrencies and to the intentions of the creators behind DeFi protocols should all be taken into account. While DeFi is the next frontier of crypto and is experiencing a boom right now, speculators should remain wary if they don't want to end up getting REKT.
This material should not be taken as the basis for making investment decisions, nor be construed as a recommendation to engage in investment transactions. Trading digital assets involves significant risk and can result in the loss of your invested capital. You should ensure that you fully understand the risk involved and take into consideration your level of experience, investment objectives and seek independent financial advice if necessary.